M&A boom bodes well for the bulls

As 2010 draws to a close, one of the world’s best barometers of corporate confidence is flashing the word BULLISH and that is leading many to think 2011 will blow away the last negative vestiges of the global financial crisis lingering in capital markets.

The barometer, which is exclusive to The Australian Financial Review, comprises the latest data on deal-making activity by the world’s biggest investment banks. The bankers who do the deals that make up the Dealogic league tables have their pulse on the global corporate sector.

They are at the leading edge of where the world is headed because their businesses rely on the confidence of boards of directors to take risks and expand by acquisition. Boards only move when they have the capital to do so or can rely on the willingness of banks and debt capital markets to finance transactions.

Equity investors, institutional and retail, can learn a lot from the deal makers and their completed and prospective deals because of what those deals say about the value of listed shares and which sectors are likely to attract the sort of 30 per cent premiums typically paid in takeovers.

Apart from mergers and acquisitions, the Dealogic data includes comprehensive coverage of equity capital markets, including share sales such as the $4 billion
QR National
float, and debt capital markets, including the $US3 billion in bonds sold in the United States by Fortescue Metals Group in the past three months.

It is clearly contrarian to be talking bullish when the world is full of doomsday commentary about Europe’s basket cases. Sure, bond spreads, which are a measure of risk, have widened in Spain, Portugal, Italy and Belgium to the highest levels since the inception of the euro in 1999, but M&A is an equally strong tool for gauging future expectations.

Announced M&A in Australia for 2010 of $128 billion is the highest in three years and just short of the record set in 2007.

Behind that huge volume of announced takeover activity is a more telling figure that has not escaped the bankers and analysts looking for insights into market valuations.

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Inbound M&A flow to Australia this year hit $US58.4 billion, up 34 per cent on 2009. The volume, which has surpassed the $US50 billion mark for the first time, is driven by buyers from Asia, Canada and the United States. Those numbers don’t include the $1.5 billion takeover of five ports in Australia owned by DP World by a consortium led by Citi Infrastructure and DP World, announced before Christmas.

Investment bankers and fund managers say the flurry of deals is proof of how cheap Australia’s listed companies are relative to those in other countries. One telling example is the US fund manager who valued QR National at $3.80 but was able to buy it in the IPO at $2.55 a share.

Foreigners were willing to buy more than $2 billion of QR National stock despite the damage to the country’s reputation from the mining tax debacle, the uncertainties created by the national broadband network and the populist decision making of the minority federal government.

Retail fund flows in Australia have been weak but that has not stopped the local IPO market recording $US7.3 billion in total volume transaction, which is triple the level of 2009 and the highest since 2005, thanks to QR National and about 59 other deals.

An obvious message from the Dealogic data is the rapid pace of recovery in overseas capital markets, particularly in the US and Asia.

The global IPO market is booming, with a total volume of deals this year of $US275.4 billion, the second highest on record behind 2007. The fourth-quarter volume was a record and included the two highest months for global IPO volume: $US50.9 billion in October and $US50.3 billion in November.

In the debt markets, Australian companies have this year tapped the global bond market for $17 billion, the highest level on record. Most of this was driven by Australia’s major banks funding their balance sheets, but an increasing number of industrial companies are bypassing banks and raising debt offshore.

Bankers strive to be No. 1 in the league tables, even though that does not necessarily mean they made money on the deals.

This year the No. 1 bank in terms of completed Australian M&A was
Macquarie
, which has been under intense pressure to prove a relatively new and somewhat risky global strategy under chief executive
Nicholas Moore
.

The fact that Moore pipped Goldman Sachs and Bank of America/Merrill Lynch for the top M&A spot will surprise those who made the mistake of writing off the Macquarie machine. Macquarie, which is virtually a proxy for global corporate activity, has in the past three months done sizeable deals in Russia, the Czech Republic, Mexico, Switzerland, South Africa and India, as well as Australia.

Global equity capital markets volume in 2010 was just below the level of 2009 but the fourth- quarter data captures the prevailing bullish mood. It was a record volume of activity at $US330 billion, up 63 per cent on the September quarter.

A key number closely watched by analysts and investors is the announced M&A pipelines, and these are very robust. Morgan Stanley alone has $US369 billion of deals pending.

The last word on investment banking for 2011 comes from Goldman Sachs chairman and chief executive Lloyd Blankfein, who told Nomura this month that investment banking was the business that had the most potential upside next year.

There has been a significant but little remarked development in the federal government’s approach to carbon pricing that has potentially severe negative implications for the country’s coal-fired generators.

The committee this week released a set of 11 principles for assessing carbon pricing mechanisms. It is pretty clear that the principles have been heavily influenced by the Greens, who oppose compensation to coal-fired generators. The principles did not include any specific item covering such compensation. There is a clause covering energy security, but that is standard in all carbon pricing mechanisms.

Excluding compensation from the discussions is in stark contrast to the Rudd government’s carbon pollution reduction scheme (CPRS), which would have paid compensation of up to $4 billion to coal-fired generators. The CPRS also envisaged $6 billion in compensation payments to low and middle-income households and billions more dollars to emission-intensive, trade-exposed industries.

The Greens appear to be having a strong influence over the committee’s deliberations.

The lack of an explicit commitment to consider compensation for coal-fired generators will be a big worry for new Victorian Liberal Premier
Ted Baillieu
.

Baillieu has been a big supporter of the La Trobe Valley, where Victoria’s brown-coal-fired power stations are located. He likes the generators because they provide relatively cheap electricity as well as being a key employer.

His predecessor as premier,
John Brumby
, who is leaving Parliament, previously promised to cut the operations of the Hazelwood power station in the La Trobe Valley by 25 per cent to reduce carbon emissions. But he was planning on funding the partial shutdown with federal money.

That leaves Gillard and Swan facing a nasty fight with the states over the closure of coal-fired generators.